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A REIT, or real estate investment trust, is a company that owns, operates, or finances real estate. Investing in REITs is an easy way to add real estate to your portfolio, offering diversification and access to historically high REIT dividend payouts.
How REITs work
REITs own many types of income-generating properties such as shopping malls, hotels, office buildings, apartments, resorts, self-storage facilities, warehouses, and even cell phone towers. Most REITs concentrate on one type of property, but some include multiple types of property.
REITs typically rent out properties they own and collect rent as their main source of income. Some of his REITs do not own real estate, instead opting to fund real estate transactions and generate income from interest on the financing.
To qualify as a REIT, a company must:
- Invest at least 75% of your total assets in real estate.
- At least 75% of your gross income comes from property rentals, mortgage interest to finance your property, or property sales.
- Pay at least 90% of taxable income as shareholder dividends each year.
- Must be a taxable entity as a corporation.
- It is governed by a board of directors or a board of trustees.
- Have at least 100 shareholders.
- No more than 50% of the shares held by no more than 5 individuals.
Reasons to invest in REITs
The main reasons to consider investing in REITs are:
touch real estate
One of the primary reasons to invest in REITs is the exposure they provide to real estate (residential, commercial or retail) without the need to purchase individual properties directly.
“This provides an opportunity for individual investors and smaller institutions to invest in real estate without the large financial commitments for due diligence and the inherent risks associated with investing in individual properties.” said Freddy Garcia, CFP, Vice President of Left Brain Wealth. Operated in Naperville, Illinois.
Robert DeHollander, CFP, a financial adviser in Greenville, South Carolina, points to his cabin in the mountains that was recently destroyed by lightning. “There’s a headache factor when you own real estate directly,” he says. “If you invest in his securitized REIT, you don’t have to deal with toilets, tenants, garbage, fires, etc.,” he says.
Earn high dividends
To qualify as a REIT, a company must pay at least 90% of its taxable income to shareholders. That makes REITs an excellent source of dividends. “He buys REITs because people usually like the income,” he says. “Especially now with historically low interest rates.”
Data analyzed by NYU’s Stern School of Business shows that as of January 2020, REITs are paying an average dividend of 3.93%, although certain REIT sectors may pay higher dividends. For reference, the S&P 500 fund offers a dividend yield of around 1.71% as of August 2020.
Diversify your portfolio
Because real estate is an asset class that is not directly tied to traditional markets, REITs can strengthen their portfolios when markets plunge.
“REITs offer a unique risk/reward profile that doesn’t always correlate perfectly with stocks and bonds,” says Michael Yoder, principal of Yoder Wealth Management in Walnut Creek, California.
For example, during the dotcom recession, REITs rose every year from 2000 to 2002.
Past returns aren’t bad either. Over the last 20 years, REIT total return performance has outperformed the S&P 500, Russell 1000 (large cap), Russell 2000 (small cap) and Bloomberg Barclays (US aggregate bond).
Disadvantages of REIT investment
That said, investing in REITs is not without its drawbacks. REITs generate income through dividends, but REIT dividends are typically taxed at higher tax rates than stock dividends. You also need to be prepared for market fluctuations associated with REIT investments.
Scott Bishop, CFP, Executive Director of Wealth Solutions at Avidian, said:
“REITs pay most of their profits directly to investors in the form of dividends, so there are potential tax implications,” says Garcia.
Most of the income a REIT distributes to its investors is counted as recurring income rather than qualifying dividends. This means that they will be taxed at the marginal income tax rate, rather than the preferential lower rates accorded to long-term capital gains and most other dividends. As a result, REIT dividends can be taxed as much as 37%, depending on the tax jurisdiction. That said, by December 31, 2025, REITs may be able to deduct up to 20% of their dividend income, bringing the effective REIT dividend tax rate up to 29.6%, according to REIT representative body Nareit. Become. This still exceeds the maximum tax rate of 20% on qualified dividends and long-term capital gains.
Depending on the category of real estate in which the REIT invests, the economic impact can make the investment highly volatile.
“Mall REITs such as CBL, SPG and WPG, for example, have struggled significantly due to Covid, but a trend away from physical stores has also contributed to their recent underperformance,” says Garcia. “Healthcare and residential REITs tend to be less economically sensitive than REITs for industrial, commercial, or retail use.”
Publicly traded REITs are traded on stock exchanges and priced on a continuous basis just like stocks and bonds. This gives them liquidity similar to those investments.
However, other public REITs are not listed on major exchanges. This typically limits liquidity to the point that it cannot fund repurchase offers or secondary market transactions. In either case, the investor may not be able to sell the desired number of shares or may have to wait to sell. Similarly, private REITs are sold by private placement and cannot be easily offloaded, except for a specific period of time at a price set by the sponsor.
“Private REITs are much more risky, and there have been several scandals that have given all REITs a bad reputation,” says CFP’s David Haas, founder of Cereus Financial Advisors in Franklin Lakes, New Jersey. “Private REITs should only be marketed to investors who understand the risks and are prepared to handle them.”
That said, the REITs and REIT funds that most investors invest in are publicly traded and offer liquidity similar to other publicly traded securities.
Four types of REITs
There are four main types of REITs.
- Stock REITs. Most REITs are publicly traded equity REITs, which own or operate income-generating properties such as office buildings and multifamily homes. According to Nareit, over the last 40 years, his REIT index of stocks only has returned 11.28%.
- mREITs. An mREIT, also known as a mortgage REIT, finances income-generating real estate by purchasing or originating mortgages and mortgage-backed securities and earning income from interest on investments. Over the past 40 years, the Mortgage REIT Index has returned 5.02%.
- A public unlisted REIT. These are REITs registered with the SEC but not traded on a domestic stock exchange. These types of his REITs may have limited liquidity.
- Private placement REIT. These REITs are exempt from SEC registration and are not traded on domestic stock exchanges. These can generally only be sold to institutional investors.
How to buy REITs
If the REIT is listed on a major stock exchange, you can buy shares in the REIT the same way you buy shares in any other public company. You can also buy shares in REIT mutual funds or exchange-traded funds (ETFs). Purchasing a REIT ETF or mutual fund may offer more liquidity than buying traditional REIT stock.
Private REITs are a little more complicated. They are usually restricted to institutional and accredited investors who have direct access to the fund or access through a private network. They also typically have much higher minimum investment requirements and can be much more difficult to offload.
Frequently asked questions about REITs
Why Should You Invest in REITs?
REITs often perform independently of the stock and bond markets, making them a good addition to your portfolio. This helps diversify your asset allocation. REITs typically pay high dividends, which can provide income to cash flow-seeking investors. It also provides an opportunity for investors who want to participate in large real estate investments without the hassle of individual purchases.
How are REIT dividends taxed?
REIT dividends are generally taxed as ordinary income. This means it will be taxed at the investor’s marginal tax rate, which could reach 37% in 2020.
How much of my portfolio should I put in a REIT?
The right mix depends on your goals and risk tolerance, but many advisors recommend investing 3% to 10% in REITs.
What are the risks of investing in REITs?
While REITs don’t necessarily correlate with what’s happening in the stock market, they can be volatile like stocks and are vulnerable to economic conditions.
“Office buildings, for example, can be under threat as more companies choose to expand their remote workforce,” says Yoder. “Look at his REI where he spent two years building a brand new headquarters in Seattle. [Recently]However, they have announced that they will vacate the building in favor of smaller satellite campuses and increased remote work. ”